Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Jiangsu Huahong Technology Co., Ltd. (SZSE:002645) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Jiangsu Huahong Technology Carry?

As you can see below, at the end of September 2023, Jiangsu Huahong Technology had CN¥1.16b of debt, up from CN¥699.9m a year ago. Click the image for more detail. On the flip side, it has CN¥950.0m in cash leading to net debt of about CN¥205.1m.

A Look At Jiangsu Huahong Technology's Liabilities

According to the last reported balance sheet, Jiangsu Huahong Technology had liabilities of CN¥1.44b due within 12 months, and liabilities of CN¥753.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥950.0m as well as receivables valued at CN¥658.9m due within 12 months. So its liabilities total CN¥580.5m more than the combination of its cash and short-term receivables.

Given Jiangsu Huahong Technology has a market capitalization of CN¥4.69b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Jiangsu Huahong Technology can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Jiangsu Huahong Technology made a loss at the EBIT level, and saw its revenue drop to CN¥7.3b, which is a fall of 13%. We would much prefer see growth.

Caveat Emptor

Not only did Jiangsu Huahong Technology's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥216m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥99m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Jiangsu Huahong Technology , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.